Use of Cash Collateral

When a lender has a claim against a bankruptcy debtor, and the claim is secured by a lien on property of the debtor, the Bankruptcy Court balances the interests of the lender and the borrower-debtor in the property. One such balancing concerns the debtor’s use of the property, the collateral. For example, if the collateral is investment real estate, the loan documents may identify additional components of collateral, such as personal property and “cash collateral” such as rents. An assignment of rents may entitle the lender to receive all rents.

The Bankruptcy Code has a section protecting the secured creditor against a debtor’s ungoverned use of cash collateral. In Bankruptcy Code Section 363(c)(2), the Congress prohibits debtor use of cash collateral without creditor consent or a court order. Typically, in the real estate context, the debtor will negotiate with the lender for the use of enough of the cash income from the property to maintain the property. For example, if rents are $100,000.00 per month, the debtor may propose to use $60,000.00 per month to maintain the property and to fund the debtor’s administrative expenses. If the lender does not consent the debtor may request a court order approving such use of cash collateral. If and when the court approves, the problem is solved.

In a Chapter 11 case, timing is important. Because the debtor company cannot operate without cash, a cash collateral agreement or order at the outset of the Chapter 11 case can be vital. It is possible for a debtor, alert to wider and later issues in the Chapter 11 case, to accomplish more in a cash collateral “stipulation” (agreement with lender) than cash collateral use by itself. Another issue in every Chapter 11 case having a secured creditor is “adequate protection” of the collateral against loss in value. If debtor files its Chapter 11 case on January 1, lender is entitled to protection from decline in value of its interest in the collateral after January 1—because lender is prohibited from seizing its collateral by the bankruptcy “stay” or freeze on collection activity.

Similarly, lender is entitled to protection from loss of its cash collateral through debtor consumption of the cash. A proper stipulation will provide lender comfort (“adequate protection”) against erosion of the lender’s security through consumption of cash. Typical forms of adequate protection are an equity cushion in the property, a lien on other property, or regular monthly payments on the debt. The debtor will normally obtain a court order at the very outset of the case in order to establish the right to use cash collateral if the lender has not agreed to such use.

The cash collateral issue is an example of the balancing process in which the court and the debtor and creditors are engaged at every stage of a Chapter 11 case.